Longevity Annuities Gaining Popularity

30504271_sIn all the years I have been in private practice, I have come to realize that no two retirees are created equal. Each and every retiree has unique goals for their retirement. They also have unique obstacles they must overcome. But at the end of the day, all retirees are living with the same market conditions, facing similar financial challenges, and they all have the same underlying goal: which is to maintain a secure retirement. But with the cost of living continuing to rise, shrinking governmental benefits, and life expectancies getting longer and longer, there is an underlying fear that I see with almost every person I speak to . . . running out of money.
In fact, as I’ve mentioned before, most people fear running out of money in retirement more than they fear death itself, by a ratio of almost two to one. Think about that for a moment. Most folks would take death first over loss of income.
This brings me to a discussion I recently had with a client; let’s call him Tony. Tony popped into my office with a recent article on this “new” concept of longevity annuities. I put “new” in quotes because, really, these aren’t new at all. They have been around for over a decade. However, their recent popularity is new because it comes on the heels of a new law that has made them more accessible than ever before. So let’s take a look.
Longevity annuities fall into the category of Deferred Income Annuities (DIAs). The basic premise of a DIA is that you hand over a chunk of money to an insurance company today, for guaranteed income years down the road. Certain DIAs are known as longevity annuities. These will pay out income later in life and are appealing to people who are concerned about running out of money if they expect to live well into their 80s and 90s. Until recently, longevity annuities did not work very well inside of retirement accounts, such as an IRA, because of those pesky required minimum distributions that you must begin taking at age 70 1/2. Now the law says that if you purchase one of these longevity annuities inside of your 401(k) or IRA, you can defer taking RMDs on the annuity piece of your retirement plan. Essentially you can defer paying Uncle Sam until age 85.
Longevity annuities are usually used as a supplement to primary retirement income sources. People typically invest just a portion of their total portfolio in a longevity annuity—say, 10 to 25 percent—and leave the rest in their other retirement accounts.
Let’s look at Tony as an example. Tony has a $500,000 IRA. Under the new law, Tony is allowed to buy a longevity annuity with the lesser of either 25 percent of that total, or $125,000. So peeling off $125,000 to put into a longevity annuity leaves $375,000 in Tony’s IRA. This strategy allows Tony to calculate his RMD on $375,000 instead of $500,000 at age 70 1/2. This will save Tony a potential of over $4,500 of taxable income in the year he turns 70 1/2. Tony can actually defer payments on his $125,000 annuity until age 85. This could potentially defer more than $80,000 of RMDs, which is taxable income to Tony when taken. Now, as most of you understand, the longer Tony waits to take payments on that annuity, the lower his life expectancy, and the higher those payments will be.
As with any annuity, you may ask what happens if someone were to pass away with money still in a longevity annuity. Well, if Tony dies before he starts taking any distributions, the full amount of his longevity annuity will go to his beneficiaries. If he has started taking income when he dies, but his account value is not zero, Tony’s beneficiaries will receive what remains.
Just as with any financial strategy, there are pros and cons. I explained to Tony that a significant disadvantage with this strategy is its lack of flexibility, which is one of the major reasons that Uncle Sam has put a limit on the amount of an IRA that can be used for a longevity annuity. Once one has been purchased, the money is there for the long term. There’s no undo button, there are no adjustments down the road. So, if you need the money right away, or you need more income from those funds than what a longevity annuity will allow for, a longevity annuity is not an appropriate investment.
Folks, look, each week I remind Cutter Family Finance readers to understand the questions to ask before incorporating any strategy into a financial system, and longevity annuities are no different. If someone is trying to steer you toward an indexed or variable annuity, when you have asked about a longevity annuity, ask why. They do not serve the same purpose. Make sure you understand the conversation and understand the specific goals behind each kind of annuity before purchasing any.
Be vigilant and stay alert, because you deserve more.